The July 2015 Budget, the first truly Conservative Budget for 18 years, gave British retailers quite a shock. The Chancellor of the Exchequer announced that from April 2016 all employees aged over 25 years would need to be paid what he termed a 'Living Wage', which he defined as a minimum of £7.20 per hour in 2016 that would rise to 'at least' £9.00 per hour by 2020. In this note we call this 'the national minimum living wage' or NMLW. The national minimum wage (NMW) is currently (in 2015) £6.50 per hour so in the first year of NMLW operation, staff on the lowest rates of pay would get a 10.8% wage rise. Compared to the 2015 minimum wage, the Government intends that staff over 25 by the year 2020 to have received a total pay rise of 38.5%. That's a lot in a world of zero inflation, where public sector pay rises are stuck around 1.0% to 1.5%.

Those of us with long memories recollect the days when Governments would do anything to stop wages rising. The leaders of the national seaman's strike, which took place six years before the current Chancellor was born, were trying to get the sort of pay rise that the Chancellor has now imposed on businesses, but were decried by Harold Wilson as a 'tightly knit group of politically motivated men' (ie malevolent Communists). So it is a bit of a treat to see a Government doing the same thing off its own bat.

We welcome the idea of improving people's living standards by paying them more and we think that the first increase, in 2016, is unlikely to have a big effect - initially anyway - upon the retail sector. It is not intended that staff under 25 years will benefit from these increases: they will still be paid the minimum wage. The generosity is not intended to be universal therefore. But in subsequent years there will all sorts of unintended (mostly negative) consequences for retail businesses, staff hours, remuneration, the number of jobs and store numbers. This paper examines the consequences of the new living wage and assesses the costs for retailers, including pensions and national insurance payments.

This paper shows that in 2020 the introduction of the so-called 'living wage' (NMLW) will cost retailers £3.26 bn per year in extra pay, national insurance and pensions. It will increase inflation by 1.1% per year to 2020, cut jobs and hours in the sector by 42,000 FTE and lead to a further 6,274 stores closing in the period 2016-2020.

Why Not Talk About These Topics Before Announcing them?

Although welcome, the Government's announcement via a Budget Statement that low-income workers would get a state-sponsored pay rise demonstrates once again what is wrong with the way the British political class takes its decisions. Very little detail has been published so far (and it starts in only seven months). This major change in policy concerning the regulation of wages would have benefitted from widespread prior discussion with interest groups, employers, trades unions, the Low Pay Commission, the Living Wage Foundation and academics to consider the policy framework, timing, the annual increases, and which workers should be covered before the decisions were announced by the Government. In fact it was not even discussed with the Low Pay Commission (the quango that sets the minimum wage): they were simply informed the day before the announcement.

Now you may say that a retail commentator like me should not snipe at the people who run the country. However if one reads, for example, King and Crewe's (2014) book on political blunders it becomes clear that such people are not infallible. In any event, I have taught economics and business strategy for several decades, studied PPE at Oxford and was President of the Oxford Union so I have had the same training as our political masters and therefore can comment freely.

The Rationale for the Living Wage Programme

Almost 3 million people are employed in the retail sector, many on part-time or short-term contracts earning the NMW or perhaps slightly more. However,

the median average hourly rate in retailing is already £7.30 in 2015 so a large proportion of retail workers must be earning more than the minimum wage and will not be affected.

one-third of retail employees are aged less than 25 years, hence a significant part of the labour force is too young to benefit directly from the new living wage. These workers are mostly in supermarkets, some discount stores and fashion.

In retail, as elsewhere in the UK, many low-pay workers receive welfare benefits from the state to increase their incomes as well as paying taxes to the state. The Chancellor is to cut welfare payments and in the Budget Statement (2015) the Chancellor shows the NMLW is intended to ensure that:

(a) work pays, and
(b) that most people get their income from the work they do rather than as subsidies from the Exchequer.

Whether this works of course depends on

(1)are the people benefitting from the new NMLW the same people who are losing transfer payments from the Exchequer, and
(2)whether the higher wages compensate in full for the fall in benefits.

The Office for Budget Responsibility (OBR) has shown that 40% of those who will gain directly from the NMLW are in families which are already doing reasonably well because their family income is in the top half of all household incomes. But the new NMLW will not be high enough to compensate most low-income households for loss of benefits and does not apply to people under 25 years. Household circumstances differ considerably and it would be illogical to expect a pay rise to meet the additional welfare requirements of every family (based on the number of children, social and care needs, disability, local rent levels etc).

To help businesses, the Chancellor has also reduced the rate of Corporation Tax (from 20% to 19% in 2017 and 18% in 2020), thus reducing the tax paid by retailers. But retailers that are making little or no profit will not benefit from this at all and if they are in industries where profits are already squeezed by price wars, such as grocery, and need a large number of staff to run their stores then the NMLW will be detrimental to their fortunes. It is rumoured that employer national insurance (which operates as a payroll tax) may be reduced or amended and this would be more helpful.

The Budget Statement (2015,1.127, p. 34) indicates that 'The government recognises that this new NLW may increase costs for some businesses'. This can be regarded as the understatement of the decade.

The Real 'Living Wage'

The actual national 'Living Wage' (LW) is calculated annually by Loughborough University's Centre for Research in Social Policy, based on the real costs of living in the UK and set out by the Living Wage Foundation, which 'owns' the concept. The NLW is set according to cost-of-living figures, but it has no legal authority: the LW simply reflects the absolute minimum needed to live a debt-free life in the UK. The LW is not over-generous, but is £7.85 nationally in 2015 and £9.15 per hour in London. The national rate is 9.0% higher than the Chancellor's NMLW and the Chancellor has made no recommendation for a higher London allowance.

The LWs for the final years of this decade have not of course been determined, but one must acknowledge that although the NMLW is set below the LW for 2016, it is very possible that the Government's NMLW may equal or exceed the overall LW by 2020.

The Minimum Wage and the Low Pay Commission

The Low Pay Commission is an independent body/quango that sets the national minimum wage (NMW) in consultation with employers and unions based on what increase seems reasonable and reflecting market conditions. Expectations about the NMW are generally pretty low: the 2015 increase was 3.0%, which was the highest increase since 2008. Interestingly enough the Low Pay Commission had originally intended to set the NMW at £7.00 per hour in 2015 but was dissuaded by protests from employers, including retailers.

What the Chancellor has done is commendable, but what he has invented is not a living wage (because it is less than the LW) but a new structure of wage rates, based on several different logics.

Minimum wage - this will be set by the Low Pay Commission and apply only to people under 25 (and possibly apprentices) based on 'reasonableness' and the economic logic of what employers can afford.

Living Wage (NMLW) up to 2020 - determined by the Chancellor to apply to staff over 25 years based at levels below the real LW and intended to compensate households for a reduction in their welfare benefits.

Living Wage (NMLW) after 2020 - to be set by the Low Pay Commission at roughly 60% of the average median wage (ie a proportion of actual wage rates).

I am sure these people are doing their best but it looks like a confused and unsystematic dog's dinner of a policy. However both the NMW and the NMLW will have the force of law after April 2016 and it will be illegal to pay staff less than the minimum rate for their age.

What Will Be The Impact of the NMLW?

It is difficult to say what effect the new NMLW will have. The (OBR) has estimated that 'only' 60,000 jobs will be lost in all sectors of the economy because of the NMLW although it confesses that it is hard/impossible to forecast.

Price rises. All retailers will be obliged to pay the new rates of pay and as labour costs rise retailers will try to pass this on to consumers in the form of higher prices. They are unlikely to be very successful in passing on all the costs, but we estimate (see calculations below) that the living wage will increase retailers' costs in 2020-21 alone by £3,260.48 mn.

Taking into account the labour shedding and operational changes they bring in to reduce costs, the NMLW is likely to increase retail prices by about 1.1% per year between 2016 and 2020.

Home delivery charges to increase. Expect prices of services with a high labour content such as courier deliveries to rise and the ending of 'free' home delivery for all except high value baskets (eg £65 minimum). The retailer costs of 'click and collect' will also rise and we would expect perhaps one third of retailers to introduce a charge unless the order size is say £40.

Staff reductions. Many retailers will shed labour by cutting staff hours and reducing staff numbers mostly by not replacing employees when they leave. A store with ten employees on the NMW in August 2015 is paying a total remuneration to staff of £65.00 per hour (plus £8.97 employer's national insurance, total £73.97). After April 2016 it will have to pay £72.50 per hour (plus £10.00 national insurance, total £82.50). By eliminating one member of staff, its hourly wage bill will be back roughly to where it was before, at £64.80 (plus £8.94 national insurance, total £73.74). Retail is not an exact science and cutting a few hours or reducing staff numbers can limit the increase in the wages bill without affecting service levels very much.

Our estimate is that the labour force reduction will be at least 60,900 workers or 2.1% of the 2015 labour force. This figure includes part-time workers of course: in terms of full-time equivalents (FTE) job losses should be around 42,000.

Store numbers will fall. We expect a proportion of stores to close as a result of the NMLW, caused by (a) higher labour costs will make marginal stores unprofitable, and (b) the higher labour costs will push some problematic retailers into administration. It is difficult to calculate the effect as store numbers have been falling anyway for many years and some of these stores would have closed at some time. We feel that the higher labour costs will accelerate this process, making the total fall in store numbers in the period around 14,000.

We expect a fall in shop numbers (high street, suburbs, parks and malls) between 2016 and 2020 of around 10,000 anyway. The 3% decline in store numbers over the next four years as a result of the NMLW will shut another 6,274 stores. The closed stores will not necessary be empty for ever but may be converted into alternative non-retail uses (gym, office, moneylender, betting office, cafe or restaurant).

Growth in Self-employed Contractors

. There will be increased pressure to get service providers to act as self-employed subcontractors, who are therefore not subject to the NMLW. At present this affects a proportion of couriers, but could be used with cleaners, security services and other outsourced work. This has been occurring for some time and it is difficult to know what the growth in self-employed contractors will be from 2016. But as the work is usually given out by retailers on a price basis, companies with a large proportion of self-employed contractors may supplant more conventional companies because they can quote lower prices.

Retailers will try to extract better terms from their suppliers. However it is difficult to see much progress on this front as they have been doing this consistently since the onset of the recession.

New technology. Customers can expect more self-service and self-scanning technology to be used as retailers try to reduce staff hours, particularly when store opening hours are extended. A lot of new technology will also be applied to warehouse operations. Online retailers may well get more benefit from new labour-saving technologies than physical stores, which may compensate to some degree the higher costs of delivery. Perhaps we will find that Amazon drones are not the fantasy that they have seemed to be up to now.

Superogatory pay rises. There will be pressure on at least some retailers that object to the Government's new pay structures to pay people under 25 years the NMLW or to pay the LW to all their staff now on the NMW. The Living Wage Foundation lists all employers certified by them as paying the LW. Very few are retailers, but their number includes Burberry, Lush and (from 2016) IKEA. Most LW employers are public sector organisations, charities, Christian bodies, management consultants, solicitors, and financial bodies, including Linklaters, Sage, Nestles, Santander, Standard Life, and Huddersfield University as well as smaller traders of local importance like Drury Tea and Coffee Company, allpay, Secure Retail Payments, Universal Fire and Security, Clamp Optometrists, Rainbow Wholefoods and Wiggly Worm Bistro. Like IKEA, some retailers reflecting on the implications of the NMLW on their own wage structures may decide that it is right and proper to go ahead and pay the LW as a minimum to all their staff.

Reworking Staff Bonuses and Benefits Packages. Retailers that currently pay a proportion of their workforce at the NMW or slightly more, but provide compensation in terms of generous staff benefits will have to rethink their pay/benefits package because it will be illegal to pay less than the NMLW, irrespective of whether staff would prefer high benefits. For example a grocers' staff card may give significant savings on colleague grocery bills that exceed the 2016 increase in pay for staff who buy most of their goods from their place of work. Nevertheless, it may be necessary to reduce everyone's staff benefits in order to fund a pay rise for the lowest paid. That is likely to aggravate staff.

Similarly staff commission systems in retailing may need rethinking to ensure that incentives are still applicable but the requirements of the NMLW are maintained.

Estimating the Costs of the National Minimum Living Wage for Retailers

Stage One of New NMLW 2016

On the assumption that one-quarter of employees over 25 years will receive the new NMLW, then additional cost would be:

Increased pay

£946.40 mn

Extra employer national insurance

£130.60 mn

Extra employer workplace pension contributions

£9.46 mn

Total

£1,086.46 mn

That does not look too bad and should be payable by most retailers. We are sure that employers will be making more workplace pension contributions, but to avoid exaggerating extra costs of the new payment we have assumed that retailers make only the minimum pension contribution and define 'qualifying earnings' as starting at £5,824.

We really need of lot more information than is published about the structure of retail pay rates and the number of hours people work. One thing we can only suspect is that smaller stores, convenience shops and small multiples are most likely to pay at or around the NMW and to have a large proportion of part-time employees.

The 2020 cost of the NMLW

For 2016 we assumed that the only people affected by the NMLW are those presently paid the MW (or a little above it). In the early stages, that seems plausible but by the time 2020 arrives we think this would be totally unrealistic. It ignores the pressures to maintain differentials for other staff, both those above 25 years and younger staff. The calculations here include the effects of the Government 'living 'wage' upon other pay grades.

Direct costs of NMLW in 2020
We assume once more that one-quarter of employees over 25 years will receive the new NMLW. The additional costs would be:

Increased pay

£1,670.14 mn

Extra employer national insurance

£230.48 mn

Extra employer workplace pension contributions

£50.10 mn

Total

£1,950.72 mn

Differentials - Workers over 25 years
Workers who already received £7.20 to £8.00+ an hour before the NMLW will eventually expect salary differentials to be observed when the lowest-paid employees get pay rises from the new 'living wage'. If they were previously paid £1.00 or £1.50 more than less experienced, less qualified or less effective workers or those with no supervisory responsibilities they will be pretty fed up if their superior performance is no longer recognised and they simply are paid the same as the newest workers on the minimum rate. Not everyone will find their previous differentials are respected but we expect that around 25% will do so and they will get an average extra payment £1.30 per hour and their average week is 29 hours.

Increased pay

£726.51 mn

Extra employer national insurance

£100.26 mn

Extra employer workplace pension contributions

£21.80 mn

Total

£848.57 mn

Younger Workers Under 25 years
Another false assumption being made is that the pay of all employees under 25 will be unaffected by the higher pay rates of older workers. We think this is unlikely and that one-quarter of younger workers will get some pay rise that will go some way to bridge the gap between the NMW and the NMLW for older workers. Apart from pressure from individuals and their trades unions, retailers may find that they need to pay more to their better young employees in order to prevent them moving to a retailer that is paying more than the NMW. Many young employees are students or others looking for only a few routine hours per week, so this trend should not be over-emphasised.

Increased pay

£394.85 mn

Extra employer national insurance

£54.49 mn

Extra employer workplace pension contributions

£11.85 mn

Total

£461.19 mn

Summary of All Retail Labour Costs Impact in 2020
By 2020 therefore we estimate that

retail wages will have risen by a total of £2,791.50 mn

employer national insurances payments will rise by £385.23 mn

extra employer pension contributions £83.75 mn

Total additional costs of £3,260.48 mn

We do not argue that the new 'living wage' is wrong or unjustified, but simply that its total impacts have not been thought through properly.

References

King, A. and Crewe, I. (2014) The Blunders of Our Governments, edition, London: One World Publications.